Question

Suppose your company needs $14 million to build a new assembly line. your target debt-equity ratio is 0.84. the flotation cost for new equity is 9.5 percent, but the floatation cost for debt is only 2.5 percent. what is the true cost of building the new assembly line after taking flotation costs into account?

Answer 1

Suppose your company needs $14 million to build a new assembly line. your target debt-equity ratio is 0.84. the flotation cost for new equity is 9.5 percent, but the floatation cost for debt is only 2.5 percent. The amount required to build a new assembly line = is $ 14 million.

Equity represents the price that could be lower back to an agency's shareholders if all of the property has been liquidated and all of the business enterprise's debts were paid off. We also can consider equity as a diploma of residual possession in a company or asset after subtracting all debts related to that asset.

Equity is the possession of any asset after any liabilities associated with the asset are cleared. for example, in case you very own a vehicle well worth $25,000, but you owe $10,000 on that car, the car represents $15,000 fairness. it is the price or interest of the maximum junior magnificence of investors in assets.

In conclusion, stocks are referred to as equities because they constitute possession in organizations. They permit buyers advantage from boom but also have a chance while enterprise conditions weaken. In the subsequent time, we'll explore the variations between shares and bonds.

Debt equity ratio (debt/equity) = 0.84/1

Therefore total assets = debt + equity = 0.84 + 1 = 1.84

Flotation Cost Percentage formula = Weight of debt x Floataion Cost of debt + Weight of equity x Floataion Cost of equity

= (0.84 / 1.84) 2.5% + (1/1.84)9.5%

= 1.1413% + 5.1630%

= 6.3043%

Amount to be raised to purchase building = Cost of building / ( 1 - Total Floatation Cost Percentage)

= 14/(1-6.3043%)

= 14/0.9370

= 14.94 million

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